Question

The required return on the stock of Moe's Pizza is 10.8 percent and aftertax required return on the company's debt is 3.40 percent. The company's market value capital structure consists of 69 percent equity. The company is considering a new project that is less risky than current operations and it feels the risk adjustment factor is minus 1.9 percent. The tax rate is 39 percent. What is the required return for the new project?

Answer 1

Answer:

6.88%

Explanation:

Weighted Average Cost of Capital (WACC) = [After Tax Cost of Debt * Weight of Debt] + [Cost of equity * Weight of Equity]

WACC = [3.40%*0.39] + [10.80%*0.69)

WACC = [0.034*0.39] + [0.108*0.69)

WACC = 0.01326 + 0.07452

WACC = 0.08778

WACC = 8.78%

The required return for the new project = Weighted Average Cost of Capital – Risk Adjustment Factor

The required return for the new project = 8.78% - 1.90%

The required return for the new project = 6.88%